Finding Stocks With Untapped 'E-Value'

Mastrapasqua:Oracle
(ORCL) is probably the single biggest holding in the fund right now.

Q:It's obviously one of the largest software companies in the world, with an emphasis on databases.

Trantum: Oracle certainly has its roots in the database world, but in recent years it has been expanding tremendously into a whole variety of applications, the net result of which will permit enterprises to more and more run their back offices and their companies using Internet technology in real time. Only two companies have really come very far in this whole effort in our eyes,
Cisco Systems
and Oracle.

Q:What else is there to like about Oracle's story?

Trantum: Their operating costs were $8 billion, and they have essentially lowered that by $1 billion, and they are working well into their second $1 billion of savings.

Q:I see that Oracle has sold off considerably, from around 45 last September to around 30 now. Is there anything fundamental to worry about there?

Trantum: I don't think there is a thing to worry about, as long as [CEO] Larry Ellison is at the helm. I think Oracle has a tremendously strong competitive advantage, and that competitive advantage appears to us to be building. Their most recent quarterly numbers actually exceeded expectations, and we don't see any end in sight [to] Oracle's premier positioning.

Q:The stock's trading at about 55 times First Call's calendar 2001 profit estimate of 54 cents a share, a little more than twice its long-term growth rate of 25%. Do you think that's a reasonable valuation?

Trantum: If you look at just the absolute P/E for Oracle on 2001 earnings, it is approximately 53 times. When we take that number through our risk-adjusted process, it gets down into the high 20s.

Q:Versus what kind of a growth rate?

Trantum: I think very conservatively in the mid-30s, and it could very well be over 40%.

Q:So looked at that way, it is trading at a discount?

Trantum: Right.

Q: Let's move to another pick.

Trantum: In the last three to four years,
Proctor & Gamble
started Internet and electronic initiatives. There are probably a dozen programs that they are in various [stages] that will start to show positive results over the next 18 months.

Q:What kind of initiatives?

Trantum: For example, as Proctor & Gamble deals with its distribution networks, literally planning plant production manufacturing production to coincide with retail inventory, that whole process is virtually done by hand -- by telephone and by fax. They project that 18 months from now, maybe three-quarters or more of that whole effort will be totally hands-off and electronic.

Q:Looking at the chart, I see that the stock took a big hit last March. It's made something of a comeback since then. What next?

Trantum: Wall Street has been disappointed by the previous CEO's initiatives -- that is, having lightning speed in terms of trying to change and adapt the company to real time management. They now have a CEO, [A.G. Lafley], who is more user-friendly internally. There is a gap between the way consumer products analysts normally analyze a company and what is really going inside of a company like Proctor & Gamble. And quite frankly, they don't know the technology or have not acquainted themselves with the technology to understand it.

Q:Using First Call's number, the stock's trading at about 22 times calendar 2001 estimates of $3.27 a share.

Trantum: That's close.

Q:Versus a secular growth rate of about 11%. So it is trading at twice its growth rate, not cheap. Where is the value here?

Trantum: Our risk-adjusted P/E would be around 12 or 13 times. And we would argue that the growth rate is substantially understated and should be more in the high-double- digits, more like 18%.

Q:How about one more pick?

Trantum: Another that we position in the "e-value" sector is
Bank of New York
(BK). Bank of New York is beginning to dominate in two areas -- the custody of money around the world and assets under management. But the most important thing over the last three to four years is that Bank of New York has basically put together state-of-the-art systems for real-time closing of accounts.

Q:What about the competition?

Trantum: Basically no one else, as we understand it, is even close to their technology. In fact, they are starting to get [more] major financial service companies come in and basically use Bank of New York as an outsource supplier.

Q:In terms of valuation, where does Bank of New York stack up against other financial service companies? I've got it trading at about 25 times this year's earnings estimates.

Trantum: They are at about 24-25 times earnings. And their risk-adjusted P/E is 14.

Q:Versus a growth rate of what?

Trantum: A growth rate of about 17%-20%.

Q:So, you see some upside here, even though the shares rose about 75% from early March, right before the Nasdaq began its selloff, until the end of 2000?

Mastrapasqua: One has to always recognize that earnings estimates and growth rates are amorphous. That's what the general view is today. We are always trying to assess whether the general view is conservative. What are the upside/downside risks? What is he likelihood of upside surprises as opposed to downside surprises? And we think [being surprised on the upside] is the case of the Bank of New York, P&G, or even with some of the other e-value plays.

Q:Do you have any sense of what Bank of New York, as far as intrinsic value, is worth down the road?

Trantum: We stay away from price targets. That is a foreign concept to us. But we love Bank of New York's competitive advantage. No one can touch them in terms of unit costs and positioning. The market is huge. They have a very small share of it. And so those are all elements that we look at all the time, and Bank of New York comes out very high.

Mastrapasqua: And then you also have a macro phenomenon. Now we are in a world, over the next 12 to 24 months, where the trend in interest rates is going to be down appreciably. So we are going to eventually find ourselves in a positive yield curve. So Bank of New York will not only benefit from what we are talking about on the technological side, they are also going to benefit from the interest rate environment -- and the multiple expansion that occurs for those sector companies.

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